Legacy Wealth Weekly - Dec 16, 2016 (Changing Tone)

Penni Johnston-Gill - Dec 16, 2016

Expectations were high for the Dow Jones Industrial index to close above the 20K psychological mark this week but the suspense will have to last a few more days if not weeks. North American equity indices are closing the week flat and most of the fir

Weekly Market Wrap-Up: Changing Tone

Expectations were high for the Dow Jones Industrial index to close above the 20K psychological mark this week but the suspense will have to last a few more days if not weeks. North American equity indices are closing the week flat and most of the fireworks have been in Japan (+2.1%) and Europe (+1.3%) where investors seem to be rotating owing to the inexpensive market valuations. The key highlight this week was the outcome of the Fed meeting where we learned that members added a third Fed hike to their dot plot in 2017. This hawkish dot plot was not expected given Janet Yellen’s dovish reputation. The net result is the DXY (+1.3%) climbing to a 14-year high. The US 2-year yields jumped 11bps to 1.26%, a level last seen in 2009. US 10-year Treasury bond yields jumped 11bps to a 2-year high at 2.59%. Unsurprisingly, the CDN$ (-1.2%) bore the brunt of this new tone at the Fed. The Loonie failed to push above its 200-dma (~76.50) and our 70-cents target seems like the next destination. We reiterate our contrarian view that the CDN$ will decouple with oil prices in 2017.

Many investors are wondering if the BoC will follow the Fed and hike rates in 2017. Here is the key excerpt from the last week’s press release from the BoC: “GDP growth in the third quarter rebounded strongly, but more moderate growth is anticipated in the fourth quarter. Consumption growth was robust in the third quarter, supported by the new Canada Child Benefit, while the effects of federal infrastructure spending are not yet evident in the GDP data. Meanwhile, business investment and non-energy goods exports continue to disappoint. There have been ongoing gains in employment, but a significant amount of economic slack remains in Canada, in contrast to the United States. While household imbalances continue to rise, these will be mitigated over time by announced changes to housing finance rules.“ This excerpt suggests the BoC will be patient. After all, the gap between the Fed (75bps) and the BoC (50bps) policy rates is only 25bps. When looking at the spread between US and CDN 2-year bond yields (Chart of the Week), a proxy of future monetary policy divergence, the 47bps gap could widen to 100 bps before the market forces the hand of Governor Poloz.

Regarding economic statistics this week, in Canada, home price inflation seems levelling off with the Teranet house price index rising 11.9% YoY (from 11.8%) in November. Tighter financing rules should moderate mortgage lending going forward. In the US, as expected, the Fed delivered a 25bps rate hike. What was not expected is the Fed's guidance of three rate hikes for 2017. Admittedly, the Fed has a legitimate case, with inflation accelerating to 1.7% YoY (from 1.6%) in November with higher energy prices (+1.2% MoM) filtering through from a lower comparison base. That said, retail sales disappointed in November (0.1% MoM vs. 0.3% exp.), restrained by a 0.5% decline in auto sales. Meanwhile, industrial and mfg. production declined 0.4% MoM and 0.1% MoM respectively. On housing, higher mortgage rates may have started to bite on home demand given the decline in building permits (-4.7% MoM) and housing starts (-18.7% MoM). Surprisingly, though, homebuilders’ confidence soared, with the NAHB index jumping to 70 (from 63) in December. Elsewhere, in Europe, the outlook remains positive, with the flash mfg. PMI improving to 54.9 (from 53.7). Finally, in China, a weaker Yuan and easy lending conditions seem to support growth. Case in point: retail sales (10.8% YoY vs. 10.1% exp.) and industrial production (+6.2% vs. 6.1% exp.) both beat market expectations.

Next week, we await inflation, retail sales and the budget balance in Canada. In the US, durable goods orders, personal income/spending, PCE inflation and home sales are on deck. The BoJ talks as well.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.